local representatives OR in establishing a legal entity with a capital

investment in China.

Types of Legal Entities

Representative Office (RO)

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A representative office in China is a non-legal entity. It is dependent upon its parent company from a legal and financial perspective. The purpose of the representative office is to act as a liaison office to the parent company; liaising on all business activities occurring in the Chinese market. It is important to define what liaison means to make sure that the Representative Office is operating within its scope of business. A liaison office can only communicate, cooperate and facilitate working relationships between people, companies and organization. It cannot negotiate deals, provide physical on-the-ground or overseas services nor trade in any goods domestically or internationally (including samples). The English version of the official business scope of a Representative Office is:

Market research, product display and publicity activities relating to the foreign company’s products or services, and

Liaison activities relating to the sale of products or provision of services, and local procurement or investments, by the foreign company.

Criteria to establish a Representative Office:

The parent company must have existed for at least two years to be eligible to establish the RO in China;

RO’s may not hire local employees directly and must rely on a government-authorized employment agency – called a Labor Dispatch agency;

A RO is limited to employing four foreign employees;

There is no investment requirement because RO’s are not designated as legal entities;

The registration process takes approximately six to eight weeks to complete depending on location.

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Wholly Foreign Owned Enterprise (WFOE)

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A Wholly Foreign-Owned Enterprise (WFOE) is a common investment vehicle for foreign investors looking to incorporate a foreign-owned limited liability company in China. WFOE structures are companies that are focused on providing a service to either consumers or companies. In most cases, the company may not manufacture or trade goods. Examples of service activities include consulting, training, restaurants and management services.

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Foreign Invested Commercial Enterprise (FICE)

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A Foreign Invested Commercial Enterprise (FICE) is a common investment vehicle for foreign investors looking to incorporate a foreign-owned limited liability company in China with import and export rights, which include wholesale trading, retail and ecommerce companies.

Manufacturing companies fall under this category as well and do not require an intermediary to sell goods locally or internationally and may import raw materials for production. The registration process, however, may be more complicated than other business categories because manufacturing plants often require additional certifications, such as an environmental license.

The activities of a FICE include retail, wholesale and franchising options. When established, a FICE is often granted both import and export rights, although additional certificates from various bureaus will be required to commence international trade. A FICE may also buy and sell products freely in China without an intermediary. It is possible for manufacturing companies to apply for an extension to their business scope to include FICE capabilities and vice versa.

Other categories of foreign invested businesses include: Purchasing Centers, Research and Development Centers, Investment Companies and Regional Headquarters.

Domestically Owned Enterprise (DOE)

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A Domestically Owned Enterprise (DOE) is the main investment vehicle for mainland Chinese investors looking to incorporate a mainland Chinese limited liability company.

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Joint Ventures (JV)

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A joint venture (JV) in China is a type of foreign invested enterprise (FIE) that is created through a partnership between foreign and Chinese investors, who together share the profits, losses and management of the JV. As a foreign investor, there are two major reasons to create a JV:

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when entering a certain industry requires a local partner according to the restrictions outlined in the “Negative List”;

when a local partner can offer tangible benefits such as well-established distribution channels, government relationships or significant knowledge of the local market.

As with any partnership, in addition to the advantages of working together, JVs also face serious challenges. It is strongly recommended that prior to choosing this form of investment vehicle you consult with the foreign partner of an existing JV and an experienced JV lawyer in China to better understand the best and worst-case scenarios that exist when formulating a JV structure and to understand how one can create protective measures.

Foreign Invested Partnerships (FIP)

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A partnership provides more structural flexibility than equity joint ventures (EJV), cooperative joint ventures (CJV), and other investment vehicles. The Partnership Enterprise Law provides for two basic forms:

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General partnerships under which all partners undertake unlimited liability for the debts of the partnership; and

Limited partnerships consisting of at least one general partner and one or more limited partners. Limited partners generally do not participate in the daily management of the entity’s affairs and are liable for debts of the partnership only to the extent of their capital contributions to the partnership.

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Interestingly, the Partnership Enterprise Law also provides for “special” general partnerships for professional services firms such as law firms and accountancies.

Develop your Structural Plan for your China Company

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A RO may be suitable for businesses looking to establish a short-term presence in China with no need to generate revenue, or for very limited sourcing ventures. However, an RO should not be regarded simply as a way for new entrants to China to minimize their exposure in the event of failure because in most cases, RO’s do not provide the optimum platform for success. Here below we outline the differences between a RO and a WFOE/FICE in each main category of consideration needed to be taken to structure your China company.

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Liability

A RO is not an independent entity. It is an extension of its parent company. As such the parent company and the RO’s Chief Representative take responsibility and liability for its operations. A WFOE/FICE providers greater protection because it is a form of Limited Liability Company (LLC). However, it does not offer the same level of protection as in other jurisdictions, so an offshore holding company is often inserted between the Chinese company and its ultimate beneficiary.

Flexibility

It is possible to setup a branch company of a WFOE/FICE in other cities and expand the scope of a business to include additional lines of business. This is not possible with a RO. RO’s cannot be converted into WFOE or FICE’s. If you want to re-structure your business, you will need to setup a new WFOE/FICE, transfer all assets and people before then closing the RO.

Marketability

A WFOE/FICE is perceived as a more substantial market presence and suggests to prospective clients or partners that a company has made a long-term commitment to the Chinese market. New market entrants often overlook this, but such a perception can be a significant barrier to business development.

Business Scope

The business scope of a Chinese company lists the services that it is legally permitted to provide according to its business registration. Inversely, a company is specifically prohibited from producing anything or offering any services not specifically described in its business scope. The business scope of a Chinese company dictates the type of entity that will be chosen. ROs are limited to liaison services for its parent company (such as quality control for sourcing from China), while a WFOE is permitted to generate revenues from the commercial activities prescribed in its business license. If a business operating through a RO decides to begin selling products or services in the future, it will be required to re-establish as a new company (noting that conversion is not possible). With a WFOE/FICE, however, it is possible to expand the business scope to accommodate it.

Registered Office Address

ROs are limited to leasing office space in locations that are specifically licensed to host RO’s. They are typically in commercial office spaces. A WFOE/FICE, however, can lease any office space that is intended for its business. Neither an RO or a WFOE/FICE should use a “virtual office” concept. This is illegal and can create problems in both the short and long-term operation of the company.

Name of the China Company (in Chinese)

Name of the WFOE/FICE (2-4 characters) + Type of Company + Name of City + Company Limited

Name of the RO (2-4 characters) + Name of City + Representative Office

Total Investment and Registered Capital

There are two numbers which need to be provided to the MOFCOM and AIC: the total investment amount and the registered capital amount. The total investment reflects the total capital required to develop and run the company and the registered capital which is the capital amount used to start-up the business until the company has a positive cash-flow status. There are no minimum capital requirements in China. It is important for each company to calculate their projected budget and cash flow needs. You should invest sufficient funds to sustain the Company until you expect it to be cash flow positive. Too many investors spend too much time finding ways to minimize their capital investments, only to find out that business expenses are greater than anticipated. Operating in China is not cheap; office rent, and remuneration of experienced employees can rival that of any developed country. It is also important to keep in mind that if funds are transferred to the WFOE/FICE more than the registered capital amount, it will be treated as income and subject to tax. A RO has no registered capital requirement and instead generally pays taxes on its expenses (approximately 10% on expenses). This is a general calculation as there are formulas which must be applied to calculate the taxes for the RO. The reason a RO pays taxes is because it indirectly contributes to the revenue potential of its parent. If the Chinese tax authorities decide that an RO is generating revenues from outside its intended activities, they can levy a tax on its deemed revenues and income. A WFOE/FICE, on the other hand, is required to make an initial capitalization, which is tax free, but is expected to pay taxes on both its revenues and profit. If a Chinese entity’s expenditures exceed a certain threshold, a WFOE is, in fact, more tax efficient than the RO.

Shareholder

The shareholder of the China company is the investor to the China company. This company must be decided upon prior to the establishment of the Company. A series of documents associated with the shareholder must be notarized by the Chinese embassy or China-designated notary (in Hong Kong and Macau). The shareholder/parent company of a RO must be at least two-years old before it is permitted to establish in China. The trend is that the Chinese government is discouraging the use of RO’s and different locations may place additional restrictions upon the parent company before an RO is permitted to establish.

Authorized Signing Authority on behalf of the Shareholder

The shareholder of the Company will have an appointed Director, who will be the authorized signing authority on behalf of the Shareholder. This individual will be registered with the MOFCOM and AIC for both the WFOE/FICE and RO.

Board of Directors or Executive Director of the China Company

In a WFOE/FICE structure the shareholder will appoint a Board of Directors which is made of a minimum of three individuals OR an Executive Director which is made up of one individual. The role of the Board of Directors or Executive Director is to create the goals, objectives and strategies of the China Company. This is not created within a RO structure.

Legal Representative of the China Company

The shareholder will appoint the Legal Representative, who is by default the Chairman of the Board or Executive Director. The definition is of a natural person who oversees the legal affairs of the China company and acts on behalf of the Company. This person will be the authorized signatory for the company and the signature will be recorded with the MOFCOM and AIC. For a RO this person is called the Chief Representative and is identical to the Legal Representative.

General Manager of the China Company

The Board of Directors or Executive Director appoints the General Manager. The General Manager handles the day-to-day management of the China Company. The General Manager is required to fulfill the objectives set forth by the Board of Directors or Executive Director. In a RO the General Manager is by default the Chief Representative.

Supervisor of the China Company

The shareholder will appoint the Supervisor of the China Company. The main role of the supervisor is to safeguard and supervise the operation of a company and the work of the directors and senior management. Supervisors have wide-ranging powers from inspecting the company’s finances to recommending dismissal of directors and senior managers for violation of law to proposing shareholding meetings. This position is not applicable within a RO structure.

Human Resources

A RO is not permitted to hire Mainland Chinese directly but must use a licensed “labor dispatch” service provider. Furthermore, a RO is limited to no more than four foreign employees as Representatives. A WFOE/FICE, on the other hand, can hire as many Mainland Chinese as it would like, while its ability to employ foreign nationals is generally based on the size of its registered capital.

Ongoing operational costs

The RO has fewer ongoing compliance costs than a WFOE/FICE, particularly in respect of accounting and tax compliance. However, depending upon the length of operations and the size of the annual expenditure, a WFOE/FICE may be significantly less expensive to operate due to the lower effective tax rates and a five-year carry forward of losses.

Time to Register your Company

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Once your structural plan is outlined it is time to register your Company. China is old-fashioned when it comes to documentation. Be prepared to receive a package filled with A-4 paper that will be, at a minimum in English and Chinese. Important and key point is that ALL documents must be signed with a Black Ink pen.

The main document is an online application form where key information on the investors and the FIE should be provided. On a side note it is important to be aware that institutional documents, such as articles of association and joint venture contracts, are no longer subject to review but must still be submitted and are important documents for the company in the long-term. In additional notarized shareholder documents must be provided (notarized either by the Chinese consulate or a China-designated notary should there be no consulate). A Bank Reference Letter will also need to be submitted showing the investment capital is readily available.

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Conclusion

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Obtain pre-investment advisory services to understand what structure will help you achieve your short and long-term objectives and goals for the Chinese market. Ultimately you are looking to reduce administrative costs by making sure you have the right structure from day one.

DISCLAIMER: All information in this article is verified to the best of our ability and is assumed to be correct at time of release; however, Woodburn Accountants & Advisors does not accept responsibility for any losses arising from reliance on the information provided within. The information provided is for general guidance and does not replace specialized advice.